Now we face a disturbing decision.
Should we buy at the much higher price that is currently prevailing?
Or, Should we wait for the price to come down near our threshold price?
Let us take a real-time example. On Monday, February 25, we had a trading setup in the section: Contraction Signals, for Satyam Computers, valid for the next day, Tuesday, February 26, 2002.
This was the signal:
Contraction Signals
We have two signals:
Buy above 281.95
Sell below 274.70
Now we should take the context. The market is in an uptrend, and we are looking for new highs. In such an environment, we do not want to take the sell signals.
For Tuesday, we will buy if and when Satyam trades above 281.95. Our initial stop loss will be 274.70, although this stop loss can change quickly.
Market Action on Tuesday
Satyam opens with a gap at 286.15 far above our threshold price of 281.95.
Now what?
While it is possible to trade such gaps in many ways, we present here one relatively conservative strategy.
When we see a large gap, we wait for the first half an hour to see the price action.
Then we take the high and low of the first 30 minutes. This information is available from Trend Analyzer, if you update 30-minute bars.
The High is: 286.15
The Low is: 284.30
Now we are buyers above 285.15. We can put a buy stop at 286.20.
For stop loss, we want to give some room on the downside.
First we calculate the half hour range.
Range = 286.15 – 284.30 = 1.85
To obtain the maximum loss, we add 50% more to the range.
Maximum Loss = 1.85 + .95 (rounded off) = 2.80
If the Maximum loss is more than 1% of the stock value, you should consider if you want to take the trade.
Our stop should be 2.80 below the entry price of 286.20
This gives a stop of 283.40
Our buy is triggered after one and a half hours. Even after buying, we see that Satyam remains sideways. But, we must be patient. So far as Satyam does not hit our stop loss, we need to be patient.
Luckily, today, Satyam moves in the last part of the trading session. The trade ends with a profit. But there will be many days when this is not so. We can still take these trades, since we have clear rules for entry and exits.
